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News : EU Economy Last Updated: Jul 14, 2011 - 8:59 AM


Irish sovereign debt cut to junk; Italy remains under pressure; Possible EU summit on Friday
By Finfacts Team
Jul 13, 2011 - 6:41 AM

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Three men likely chatting in French before the meeting of the Ecofin council of EU finance ministers, Brussels, July 12, 2011: Jean-Claude Juncker, Luxembourg prime minister and president of the Eurogroup (centre), Michel Barnier, European commissioner for the internal market and financial services (left), and Jean-Claude Trichet, European Central Bank president (right).

Irish sovereign debt was cut to junk status on Tuesday night by Moody's Investor Services, which cited the probability that Ireland will need additional official financing and for investors to share in losses before it can return to the private market. Meanwhile, market pressure remains on Italy while EU leaders discuss if an emergency summit should be held on this Friday.

Ireland has joined Portugal and Greece as the third Eurozone country to have its credit rating reduced to below investment grade - -  for the first time- - and the move means further pressure on the banking system as big companies and investment funds are prevented from placing deposits in institutions with a junk rating.

Some of the funds in Irish banks are protected by a sovereign guarantee. 

The Department of Finance said on Tuesday night that the rating cut was a "disappointing development" and added that it was "completely at odds" with the recent views of other rating agencies.

Ireland still has investment-grade ratings with agencies, Standard Poor’s and Fitch.

The yield on 10-year Irish sovereign bonds rose 15 basis points to 13.35% on Tuesday, having earlier risen to a new high of 13.68%.

Italy’s 10-year yield closed Tuesday down 12 basis points (bp) at 5.56%, having earlier hit a euro-era high of 6.09% while Spain’s dropped 18bp to 5.85%. The German Bund yield rose 4bp to 2.71%.
benchmark 10-year bond yields hit a euro-era high of 6.09 per cent

"We have to eliminate any doubts over the efficacy and credibility of our budget,” Silvio Berlusconi, Italian prime minister, said on Tuesday as he argued for a €40bn austerity package which is claimed would eliminate Italy’s budget deficit by 2014.

The Financial Times reports that Opposition party leaders in Rome pledged their co-operation in parliament to pass the government’s three-year austerity programme by Friday in time for a possible emergency summit of EU leaders in Brussels that day.

The Wall Street Journal reports that Eurozone leaders are considering holding a special summit Friday to discuss the debt crisis in the single currency area, a senior European Union diplomat said.

"[The possibility of a meeting being held] is not excluded," the diplomat said.

A Spanish government spokesman also said the idea of having a euro-zone leaders' summit is being studied but has not been fixed yet.

"Such a meeting is now under study, but no final decision has been made yet," the spokesman said.

Greek Default Not Necessary: OECD's Gurria: As European finance ministers met in Brussels for the Ecofin meeting, Silvia Wadhwa caught up with the President of the OECD, Angel Gurria, who is convinced private sector creditors need to play a role in Greece's rescue:

Dutch Finance Chief on the European Debt Crisis: CNBC spoke to Dutch Finance Minister Jan Kees de Jager and asked him about fears that contagion from Greece will hurt other peripheral economies:

Moody's Statement:

Moody’s downgrades Ireland to Ba1; outlook remains negative

Frankfurt am Main, July 12, 2011 — Moody’s Investors Service has today downgraded Ireland’s foreign- and local-currency government bond ratings by one notch to Ba1 from Baa3. The outlook on the ratings remains negative.

The key driver for today’s rating action is the growing possibility that following the end of the current EU/IMF support programme at year-end 2013 Ireland is likely to need further rounds of official financing before it can return to the private market, and the increasing possibility that private sector creditor participation will be required as a precondition for such additional support, in line with recent EU government proposals.

As stated in Moody’s recent comment, entitled “Calls for Banks to Share Greek Burden Are Credit Negative for Sovereigns Unable to Access Market Funding” (published on 11 July as part of Moody’s Weekly Credit Outlook), the prospect of any form of private sector participation in debt relief is negative for holders of distressed sovereign debt. This is a key factor in Moody’s ongoing assessment of debt-burdened euro area sovereigns.

Although Moody’s acknowledges that Ireland has shown a strong commitment to fiscal consolidation and has, to date, delivered on its programme objectives, the rating agency nevertheless notes that implementation risks remain significant, particularly in light of the continued weakness in the Irish economy.

The negative outlook on the ratings of the government of Ireland reflects these significant implementation risks to the country’s deficit reduction plan as well as the shift in tone among EU governments towards the conditions under which support to distressed euro area sovereigns will be made available.

Despite the increased likelihood of private sector participation, Moody’s believes that the euro area will continue to utilise its considerable economic and financial strength in its efforts to restore financial stability and provide financial support to the Irish government. The strength and financial capacity of the euro area is underpinned by the Aaa strength of many of its members including France and Germany, and indicated by Moody’s Aaa credit ratings on the European Union, the European Central Bank and the European Financial Stability Facility.

Moody’s has today also downgraded Ireland’s short-term issuer rating by one notch to Non-Prime (commensurate with a Ba1 debt rating) from Prime-3.

In a related rating action, Moody’s has today downgraded by one notch to Ba1 from Baa3 the long-term rating and to Non-Prime from Prime-3 the short-term rating of Ireland’s National Asset Management Agency (NAMA), whose debt is fully and unconditionally guaranteed by the government of Ireland. The outlook on NAMA’s rating remains negative, in line with that
of the government’s bond ratings.

RATIONALE FOR DOWNGRADE

The main driver of today’s downgrade is the growing likelihood that participation of existing investors may be required as a pre-condition for any future rounds of official financing, should Ireland be unable to borrow at sustainable rates in the capital markets after the end of the current EU/IMF support programme at year-end 2013. Private sector creditor participation could be in the form of a debt re-profiling — i.e., the rolling-over or swapping of a portion of debt for longer-maturity bonds with coupons below current market rates – in proportion to the size of the creditors’ holdings of debt that are coming due.

Moody’s assumption surrounding increased private sector creditor participation is driven by EU policymakers’ increasingly clear preference — as expressed during the negotiations over the refinancing of Greek debt — for requiring some level of private sector participation given that private investors continue to hold the majority of outstanding debt. A call for private sector participation in the current round of financing for Greece signals that such pressure is likely to be felt during all future rounds of official financing for other distressed sovereigns, including Ba2-rated Portugal (as Moody’s recently stated) as well as Ireland.

Although Ireland’s Ba1 rating indicates a much lower risk of restructuring than Greece’s Caa1 rating, the increased possibility of private sector participation has the effect of further discouraging future private sector lending and increases the likelihood that Ireland will be unable to regain market access on sustainable terms in the near future. This in turn implies that some Irish government bond investors would need to absorb losses. The increased risk of a disorderly and outright payment default or of a disorderly debt restructuring by Greece also increases the risk that Ireland will be unable to regain access to private sector credit.

The downward pressure that this creates is mitigated in Ireland’s case by the strong commitment of the Irish government to fiscal consolidation and structural reforms, and by its success, so far, in achieving the fiscal adjustment required by the EU/IMF programme. To date, Ireland has met all of its objectives under that programme. In the first half of 2011, the primary balance target was exceeded, with tax revenues on track and lower-than-anticipated government expenditures. However, Moody’s cautions that implementation risks related to the overall deficit reduction aims of the three-year programme are still significant, particularly in light of the continuing weakness of domestic demand.

Apart from Ireland’s adherence to fiscal consolidation, Moody’s also acknowledges the Irish economy’s continued competitiveness and business-friendly tax environment. The considerable wage adjustment that occurred in the course of the crisis reflects the Irish labour market’s flexibility. Taking Ireland’s economic adjustment capacity into account, Moody’s expects that, after a period of prolonged retrenchment, Ireland’s long-term potential growth prospects remain higher than those of many other advanced nations. While the government’s debt-to-GDP burden is expected to be high compared to similarly rated sovereign credits, Ireland has managed elevated levels of indebtedness in the past, and has shown political cohesion while enacting difficult structural adjustments.

WHAT COULD CHANGE THE RATING UP/DOWN

Moody’s would consider a further rating downgrade if the Irish government is unable to meet the targeted fiscal consolidation goals. A further deterioration in the country’s economic outlook would also exert downward pressure on the rating, as would further market disruption resulting from a disorderly Greek default.

Moody’s also notes that upward pressure on the rating could develop if the government’s continued success in achieving its fiscal consolidation targets, supported by a resumption of sustained economic growth, is able to reverse the current debt dynamics, thereby sustainably improving the Irish government’s financial strength.

PREVIOUS RATING ACTION AND METHODOLOGIES

Moody’s last rating action affecting Ireland was implemented on 15 April 2011, when the rating agency downgraded Ireland’s government bond ratings by two notches to Baa3 from Baa1, and maintained the negative outlook.

Moody’s last rating action affecting NAMA was implemented on 15 April 2011, when the rating agency downgraded by two notches to Baa3 from Baa1 the senior unsecured debt issued by NAMA, which is backed by a full guarantee from the Irish government. The negative outlook was maintained.

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